Asia’s leadership of the global economic recovery is continuing unabated. And, even though heightened risks mean there may be tough times ahead again, the region is well equipped to handle them.
Asia’s remarkably fast recovery from the global financial crisis continued in the first half of 2010, despite the recent tensions in global financial markets. In fact, GDP growth in the first quarter was generally stronger than we anticipated in our Regional Economic Outlook in April. And high-frequency indicators suggest that Asian economic activity remained brisk in the second quarter. Even more notable, this is true both for economies that escaped a recession in 2009, thanks to their relatively larger domestic demand bases (China, Indonesia, and India), and for the more export-oriented economies such as Japan, the Newly Industrialized Economies (NIEs), and the rest of the ASEAN.
Two growth engines
What explains the strong economic momentum across the region? It is simple. The two “engines of growth” that spurred Asia’s recovery in 2009— exports and private domestic demand—have remained robust in 2010.
Exports have been boosted by the global and domestic inventory cycles, and by the sustained recovery of final demand in advanced economies. Private domestic demand has also continue to grow strongly across the region, despite some easing in policy stimulus, as well as increased volatility in capital inflows and equity valuations after the Euro area financial turmoil. In particular, private fixed investment has strengthened in many regional economies, on the back of higher capacity utilization and still relatively low capital costs.
After the very rapid growth rates we have seen in the first half of 2010, we believe that growth will settle to a slightly more moderate—and, importantly, more sustainable—path for the rest of this year and 2011. To be sure, many governments in the region are expected to continue making policy conditions less accommodative, but this will occur at a very gradual pace—one that is unlikely to hinder private sector demand. And, even once the inventory cycles at home and abroad have run their full course, production and exports will likely continue to grow at a healthy pace as long as the global recovery proceeds as we envisage in the July update of the World Economic Outlook.
Still strong growth outlook
Against this background, we now expect GDP in Asia to grow by about 7¾ percent in 2010, about ½ a percentage point above what we envisaged in April, before easing to about 6¾ percent in 2011.
The pace and drivers of growth will continue to differ across the region. In China, based on the strong rebound in exports and resilient domestic demand, the economy is now forecast to grow by 10½ percent in 2010, before slowing to 9½ percent in 2011 as further measures are taken to limit credit growth and maintain financial stability. In India, growth is expected to rise to 8¾ percent in 2010/11 from about 7 percent in 2009/10, as robust corporate profits and easy financing conditions fuel investment. Both the NIEs and ASEAN economies are expected to grow on average by 6½ percent in 2010, as exports and private domestic demand have surged, before moderating to 4¾ and 5½ percent, respectively, in 2011. In Japan, growth is now expected to reach 2.4 percent in 2010—mainly thanks to stronger than expected exports in the first half of 2010—before easing to 1.8 percent in 2011 as the fiscal stimulus gradually tapers off. In Australia and New Zealand, growth is expected at about 3 percent in 2010 before accelerating to 3½ and 3¼ percent, respectively, in 2011, with still robust commodity prices boosting private domestic demand.
Intensified risks
So, is it all good news for Asia? Not quite. While we have revised our baseline growth forecasts upward, we also believe that the downside risks for growth during the remainder of this year and next have intensified, especially for Asian economies that are more dependent on external demand and external financing.
The greater uncertainty in our forecasts for Asia is a direct consequence of the much greater uncertainty about the underlying strength of the global recovery after the recent financial turmoil in the Euro area.
Indeed, as the experience of global financial crisis has shown us all too well, turmoil in one part of the world can have far-reaching effects—even for countries that have little direct exposure to the source of the trouble. While Asia’s direct financial linkages to the most vulnerable Euro area economies are limited, if the European recovery stalls and spills over to global growth, that may well affect Asia through both trade and financial channels. Many Asian economies (especially the NIEs and ASEAN) are highly dependent on external demand—and their export exposure to Europe is at least as large as that to the United States. However, economies with a larger domestic demand base, such as China, India and Indonesia—what I sometimes refer to as the “growth leaders”—are relatively less vulnerable to a new external demand shock.
Contagion from a Europe-wide credit event also could materialize through bank funding and corporate financing, especially in those regional economies more dependent on foreign currency financing. Further spikes in global risk aversion could also precipitate capital outflows from the region and weaken equity valuations, undermining the positive feedback loop between favorable financial conditions and domestic demand.
On the positive side, Asia still has policy room to maneuver if such contagion were to occur. First, Asian central banks could swiftly redeploy tested instruments to overcome market disruptions, as shown by the reestablishment of the U.S. dollar liquidity swap facility announced by the Bank of Japan in May 2010. Second, the planned withdrawal of monetary and fiscal stimulus could be delayed in order to mitigate adverse spillovers to the real economy.
